Introduction to Monetary Policy
Discuss about the Financial Market for Introduction to Modern Economic Growth.
Monetary policy is defined as a process where the supply of money, its availability, rate of interest and value of money are controlled by the monetary authority or central bank or government. This process generally includes targeting an interest or inflation rate so that the price stability and trust in currency can be ensured, thereby leading towards the stability and growth of economy. There are ample ways in which the monetary policy can be tamed and managed. Monetary policy can be maintained by trading government bonds, government securities like treasury bills etc (Open market operations), modifying interest rates and altering the amount of money which banks are required to keep in their vault that is Bank Reserves. All these contains the possibility of expanding the supply of money and if altered, contracting the supply of money. The manner in which the monetary policy can be maintained or structured is by looking at the prevailing condition in the overall economy. It is either contractionary or expansionary because a contractionary monetary policy can be adopted to slow or decrease the growth rate in money supply so as to control inflation or an expansionary policy can be adopted to increase the supply of money in the economy so as to lower unemployment, stimulate economic growth etc (Corsetti & Pesenti, 2005). Within this diversified majority of population system, specialized institutions like the European Central Bank, People’s Bank of China, Reserve Bank of Japan etc exists and these are employed with a task of executing monetary policy in the economy which is often independent of the judicial or political system. Basically, these specialized institutions are referred as Central Bank and they also have other important duties such as administering the effective and proper functioning of the global financial system. In short, monetary policy aids in shaping the economic character of a country by rectifying the economic ills like inflation or deflation (Acemoglu, 2011). It is considered a very significant tool that helps in obtaining the macroeconomic goals of an economy. Without the tools it is difficult to carry on the task with ease and flexibility. Moreover, to ensure a fuller development it is essentially needed that the tools must be used in a proper manner.
Monetary policy is the planning of a monetary authority of a country which helps a country to manage and maintain supply of money within the country. Supply of money is the essential requirement because it keeps the momentum in progress and helps a country to avail innumerable opportunities in terms of growth and productivity. The monetary policy also deals with the inflation rate and interest rate which helps to maintain price stability (Australian Government, 2013). The central bank of Singapore is named as MAS or The Monetary Authority of Singapore which performs all of the functions associated with central bank. MDD or The Monetary and Domestic Markets Management Department of Singapore are in charge for the implementation of monetary policy. The MAS is basically named as the central bank of Singapore and it conveys a diversified extent of functions of central bank. MDD or The Monetary and Domestic Markets Management Department is accountable for the implementation of monetary policy in Singapore that comprises of managing the liquidity of banking system by liquidity facilities and operations of money market and the rate of exchange by interfering in the foreign exchange markets. The monetary policy of Singapore primarily aims at achieving price stability to sustain economic growth. With increasing capital flows and globalization, determination of the most appropriate monetary policy in a small economy like Singapore is very difficult. It is a challenge for the policymakers to evaluate various trade-offs among the policy objectives, determine the most relevant economic developments, identify the key constraints and measure the level of transparency associated with monetary policy. In relation to this context, Singapore has established a rare framework of monetary policy that is focused on the exchange rate and aims to sustain economic growth. The main objective of MAS since 1981 is to manage the Singapore dollar (SGD) against the undisclosed basket of currency. This means that the SGD’s value is to be compulsorily measured against a specific thing instead of using a solitary currency as is done by Hong Kong (Junankar, 2013).
Singapore’s Monetary Policy
The instrument which is used as the basis of Singapore’s monetary policy is the exchange rate instead of interest rate used by other countries. The Monetary Authority of Singapore is responsible for the SGD exchange rate against it’s the currencies of the major associates and competitors. The Singapore trade basket is appraised from time to time so that the changes reported can be accounted for and the trade pattern can be traced for which the monetary policies are to be framed (Devereux & Engel, 2011). There is an undisclosed target band for this trade weighted exchange rate, which increases and decreases with the other market factors. Now this rate is allowed to change keeping in mind the inflation rates all around the worlds and also the domestic price pressures. The Monetary Authority of Singapore takes action by involving itself in the exchange market of foreign countries in case there are heavy fluctuations in the Singapore dollar exchange rate. Heavy fluctuation needs to be managed in no time otherwise there might be a huge volatility and make the country vulnerable to risks.
A basket of currency of the relevant trading partners is used by the MAS and is trade-weighted in such a way so that the money of tremendous trading partners gathers an increased weight and thus makes for a better and integral part of index (Devereux & Engel, 2011). The composition of this basket is revised and reviewed periodically so that the variations in Singapore’s trade patterns can be considered without disclosing information on the boundaries and index of target or policy band. Whenever required, MAS interferes in the foreign exchange market in order to sustain a trade-weighted exchange rate of SGD, commonly called as (S$NEER) Singapore Dollar Nominal Effective Exchange Rate, inside its policy band. Other countries acquire either a fixed or a floating rate of exchange but the policy of Singapore is a mixed character of both. SGD is permitted to hover freely and evaluation of the strength of the currency is done by MAS on the basis of Nominal Effective Exchange Rate. MAS evaluate the movements in NEER on a day-to-day basis to ensure that it moves in an efficient manner within its policy band. The MAS concentrates mainly on three characteristics of this band that are band width, slope of the band and the level, the band is centered (Mankiw & Taylor, 2015). Whenever the NEER comes at the edge of policy band on any side, MAS interferes in the foreign exchange markets by using forward or spot transactions. It can also interfere prior to reaching of band or can allow NEER to breach the band before its intervention. This interference can also be done by buying the dollars of Singapore against the dollars of US in order to stem the depreciation of Singapore dollar or by selling a Singapore dollar against the US dollar in order to abate the monetary policy in Singapore is reviewed on a half yearly basis in order to ensure that the policies of the country are in consistence with the market conditions and the economic scenario. This helps the government to maintain a low inflation rate for sustainable economic growth of the country (Junankar, 2013). A Monetary Policy Statement (MPS) is published by MAS on a semi annually basis in every April and October. This statement explains about the country’s monetary, economic and inflationary conditions and lays down the governments measures and controls for the upcoming six months. The monograph by Monetary Authority of Singapore on the country’s exchange rate policy states the monetary policy system of Singapore which is based on exchange rate along with the encounter since its acquisition and revisions made thereto. Singapore has an unlocked policy of capital account. The country’s selection of rate of exchange as the anchor of monetary policy directly implies that the rate of interest and supply of money within the country are in-house appreciation of Singapore dollar (Junankar, 2013).
MAS and Monetary Policy
The MMO’s (Money Market Operations) by MAS are conducted in order to ensure proper liquidity in the current system of banking to cope up with the banks requirement for reserve and other balances. There are mainly three features of the monetary policy of Singapore (Dawson, 2006). Firstly that the dollar of Singapore or SGD is managed against a currency basket, therefore, reducing the volatility factor which would have increased if the focus was put on one currency. Secondly, the trade-weighted rate of exchange is permitted to oscillate within the band as decided by the MAS. And thirdly, revision of the exchange rate policy band, this keeps the country informed and later as to when and where changes in the monetary policy are required. These features together have succeeded to provide stability to the open economy of Singapore. The implementation and formulation of the Singapore’s monetary policy are kept separate so that concentration is not divided among them. The MAS refrains itself from intervening in the market and lets forces do its job but sometimes it steps in when it sees that exchange rate is acting volatile or not moving in an orderly fashion.
Formulation of monetary policy is considered an unrelated function of MAS to maintain the unburdened decisions of monetary policy. The Economic Policy Group is accountable for the framework of monetary policy of Singapore and it regularly assesses the exchange rate path in order to prohibit an incorrect alignment in the currency value of Singapore dollar. The monetary policy is assessed on twice a year by MAS to assure consistency and efficiency with market conditions. After every assessment, a Monetary Policy Statement is liberated in the Macroeconomic Review of MAS that also aims to enhance transparency by providing accurate and complete details on the review and evaluations of macroeconomic developments in the economy of Singapore (Dawson, 2006). These steps have also allowed bank analysts to come at a comparatively similar estimate of the Singapore Dollar Nominal Effective Exchange Rate. They can theorize the presence of MAS from the price activity when according to their models of S$NEER, the exchange rate is near to the expected boundaries of the policy band. The intervention of MAS in the foreign exchange has a significant impact on the liquidity conditions in the system of banking. By taking into consideration other factors of market as well, MAS decides on matters relating to the liquidity of Singapore dollar that is enough to fulfill the demand of settlement and reserve balances of banks (Horton & Ganainy, 2010). For money market operations, the instruments include foreign exchange swaps, MAS bills, direct borrowing etc. Recently in the year 2001, these MAS bills were introduced as they assist the banking system in an efficient liquidity management.
Exchange Rate Management by MAS
The exchange rate of Singapore is conducted by the MAS to devalue or value relying on whether the inflationary pressures are powerful or weak. Identifying the causes of fall back in monetary policy, MAS measures the attitude of policy and operates taking into consideration the expected developments and account trends in the outside environment and domestic economy. With an exchange-centered monetary policy, Singapore has prevented high inflation thereby achieving economic growth in the recent decades (Roubini, 2016). By taking advantage of high rate of savings, ample foreign reserves etc, Singapore’s monetary policy has been triumphant in offsetting the pressures of inflation by guiding the exchange rates. For example, in the year 1980, high capital flows and shocks of oil price triggered inflationary pressures in the economy but by appreciating the (TWI) Trade-Weighted Index of exchange rate by 30% during 1981-85, the inflationary pressures were controlled (Coyle, 2014).
In the recent financial crisis, a gradualist approach was adopted by the MAS in its monetary policy decisions taking into consideration the outer shocks and the significance of exchange rate in uncertain times. In the year 2008, MAS simplified its policies by adopting a nil percent appreciation of the S$NEER band that too in inflationary pressures but it was re-centered downwards in the year 2009. During this period, budgetary measures played a very significant role in counter cycling the stabilization of the economy and as a result, the economy of Singapore arose (Enria, 2014). As soon as this broad-based enhancement or recovery started to root in the economy, the monetary policy was further pre-emptively tightened in the year 2010 and for this purpose, the S$NEER policy band was re-centered upwards and the gradualist approach was restored back. This also marked the termination of an accommodative stance of monetary policy. Since the year 2010, strong capital inflows are witnessed by Singapore together with the broad-based deficiency of the US Dollar (Coyle, 2014). In the operations of monetary policy, MAS did not undertake any flow of capital management measures despite the monetary flood. The exchange rate policy continues to be effective in keeping the exchange rate at a path corresponding to the medium-term price stability. As the Singapore economy is very small and open, MAS has to face very large and high inflows of capital but because the financial markets of Singapore are liquid together with the assistance of well-established banking system, the capital flows can effectively be intermediated. Capital flows can threaten the macroeconomic stability of an economy but monetary policy has proved to be a very effective tool in addressing inflation and capital flows (Steven & Ramayandi, 2011). While a strong monetary policy can diminish the asset prices, it can also lead to a lower growth of GDP in an economy. This can in turn lead to unwanted volatility into the exchange rate, hence jeopardizing its importance as a cornerstone of stability. The efficiency of Singapore’s exchange rate based monetary policy as an anti-inflationary policy can be proved by the truth that domestic or home inflation has become comparatively low in the last few decades with an average of 2.1% per annum (Mathai, 2012).
Monetary Policy Review in Singapore
Therefore, the monetary policy of Singapore is being resumed to be formed based on inflation and growth considerations even though MAS is aware of the impacts that it may create on the financial stability of the economy. This is the reason why MAS chooses to adopt this approach for destabilizing the effects of capital inflows. Even though monetary policy of Singapore focuses on the stability of prices, it also teams with a macro and micro-prudential supervision to achieve financial stability. This approach is also referred as Monetary Policy Plus by the MAS (Steven & Ramayandi, 2011). It is also noted that in the recent years, citizens of Singapore complained about higher cost of living and cost of housing and in relation to this purpose, the Singapore government initiated several rounds of cooling or quantitative measures between 2009 and 2013 in response to this. These measures focus on ensuring a stable property market and other latest measures that are initiated, has the effect of increasing rates of stamp duty, tightening loan to value ratios etc (Mathai, 2012).
The choice of Singapore of exchange-based rates rather than rate of interests as a principal instrument of monetary policy is based on its increased degree of openness to capital flows or trade and its small size (Enria, 2014). The philosophy behind the exchange rate monetary policy is to conserve the buying power of SGD so that the confidence in currency can be attained. Even in the latest financial crisis that made the task of MAS more challenging, it did not had to take extraordinary measures of monetary policy (Gopinath & Rigobon, 2008). As some of the specific characteristics of Singapore necessitate this unique monetary policy, there are few more factors that have enhanced the operations of this policy in the recent decades like the high rate of savings in the public sector because of the budgetary surplus of government, credibility of MAS through its efficient policy decisions like its focus on medium term inflation trends etc. As MAS has adopted a medium to long term orientation in establishing a monetary policy, the volatility of exchange rates has been effectively reduced, thereby assisting the economy, business and other households (Gopinath & Rigobon, 2008). Hence, the effectiveness of monetary policy operations in Singapore is because of the framework that it’s a part of. It must be noted that monetary policy cannot function in emptiness and thus the proper organization between the fiscal and monetary policy in Singapore has ensured macroeconomic solidity in recent decades. But now the policymakers can forecast inflation in Singapore by the New Phillips Curve (NPC) as according to empirical evidence, NPC can forecast inflation on the basis of real marginal costs (Bitros, 2015).
To conclude, it can be said that the effectiveness of the Singapore’s monetary policy (exchange rate policy) is due to its broad framework. The elongated framework enables to have a strong command over the economy and hence the effectiveness is more and prolonged. In short, it can be said that the vastness of the monetary policy is an essential component in establishing the framework. Along with the monetary policy it is essential to have strong government policy that helps in creating a favorable image and leads to effective result. The monetary policy needs other pillars for support so that it can be effectively implemented. The policies of flexible prices and wages, an efficient financial market along with the huge corporate sector and proper fiscal policy serve as a pillar to the monetary policy in Singapore (Bitros, 2015). The strong coordination between the monetary and fiscal policy in Singapore has successfully resulted in the country’s macroeconomic stability since last few decades including the phases of financial crisis undergone by all great economies of the world. Singapore is better placed and the structure of the policy clearly indicates that it is result oriented.
References
Acemoglu, Daron, Introduction to Modern Economic Growth (Princeton University Press, 2011).
Australian Government, Budget Strategy and Outlook, Budget Paper (Commonwealth of Australia, 2013)
Bitros, George. “The real exchange rate of euro and Greek economic growth”. The Journal of Economic Asymmetries, 12 (2015) : 100
Coyle, Diane, GDP: A Brief but Affectionate History (Princeton University Press, 2014).
Dawson, Graham, Economics and Economic Change (Prentice Hall, 2006)
Devereux, Michael,B & Engel, Cameron, “Monetary policy in the open economy revisited: Price setting and exchange rate flexibility”. Review of Economic Studies, 70, 2011, 765–783
Gopinath, Gita & Rigobon, Roberto, “Sticky borders”. Quarterly Journal of Economics, 123(2), 2008, 531–575.
Horton, Main and Ganainy, El Fiscal policy: taking and giving away, International Monetary Fund (Oxford Press, 2010)
Junankar, Pramod, Australia: The Miracle Economy. IZA Discussion Papers 7505 (Institute for the Study of Labor, 2013)
Mankiw, N.Gregory & Taylor, Mark, P, Economics, (Andover: Cengage Learning, 2015).
Mathai, Koshy, Monetary policy: stabilizing prices and output (International Monetary Fund, 2012)
Steven, Pennings & Ramayandi, Arief. “The impact of monetary policy on financial markets in small open economies: More or less effective during the global financial crisis”. Journal of Macroeconomics, 44 (2011): 60-70
Corsetti, Giancarlo & Pesenti, Paolo, “International dimensions of optimal monetary policy”. Journal of Monetary Economics, 52(2), 2005, 281–305.
Enria, Frank. Disclosure of Accommodative Monetary Policy meaning. (SA: Frank Enria, 2014)
Roubini, Nouriel. “Troubled Global Economy.” Time Magazine, January 14, 2016. Accessed July 5, 2016.
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